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External Debt Problem: Magnitude, Causes & Reflief Measures | Economics


In this article we will discuss about:- 1. Magnitude of External Debt Problem 2. Causes of External Debt Problem 3. Debt Relief Measures 4. India and External Debt.

The poor countries are faced not only with the problem of persistent balance of payments deficit but also of falling export earnings, low growth rate and lack of liquidity for financing their development programmes. The complex situation in which they are placed has landed them in the grips of international debt crisis of serious dimensions.

Any default on the part of some of these indebted countries is likely to engulf the entire international financial system in grave crisis or even collapse. It is, therefore, of much importance that the advanced countries and multilateral financial institutions address themselves in all seriousness to the problem of international debt crisis.

Magnitude of External Debt Problem:


The Organisation for Economic Co-operation and Development in its report published in 1991, pointed out that the total external debt of the developing countries stood at a staggering total of 1490 billion dollars at the end of 1991 compared with 1446 billion dollars at the end of 1990. The claims held by OECD countries (24 rich industrial countries), either directly or indirectly through the international organisations accounted for 1306 billion dollars.

The share of Latin America in the total stock of external debt declined from 41 percent to 29 percent in the decade ending 1992. On the other hand, Asia’s debt stock got doubled over this period on account of rapid growth of debt in the countries like China, India and Indonesia.

Many of the indebted nations have already been engulfed by the situation of debt trap in which they have to procure additional borrowing for the servicing of the outstanding loans. Although there is divergence of opinion among the economists as to when precisely a country gets caught in the debt trap, yet the financial prudence will suggest that such a situation should not occur as the borrowing country, placed in such a situation, has no net positive aid flow to finance the development activity.

According to the World Bank Report, published in 1998, the external debt in 1996 of 10 most indebted nations among the LDC’s in billion dollars was recorded as – Brazil (179.0), Mexico (157.1), Indonesia (129.0) , China (128.8), Russian Federation (124.8), Argentina (93.8), Thailand (90.8), India (89.8), Turkey (79.8) and Philippines (41.2). The gravity of the problem is determined on the basis of their borrowings in relation to their respective GNP and exports of goods and services.


In 1996, the external debt as the ratio of GNP was the highest at 121 percent in the case of Nigeria, followed by Algeria at 81 percent, Indonesia at 67 percent, Thailand at 56 percent, Philippines at 54 percent and India at 28 percent. The external debt as a ratio of export of goods and services was the highest in 1996 in case of Argentina at 323 percent followed by Brazil at 293 percent, Nigeria at 240 percent, and Indonesia at 236 percent.

In case of India, this ratio stood at 152 percent. Although India has not reached the situation of debt trap, yet it was perilously close to it and effective and concerted measures were required to keep away that situation.

According to the World Bank Report, published in 2006, out of the 10 top indebted countries, China was at the top with external debt amounting to US $ 322.8 billion, followed by Russian Federation (251.1), Turkey (207.8) and Brazil (192.1). India was placed at the 5th position with an external debt burden of US $ 169.63 billion. The rates of debt to GNP was the highest at 102.2 percent in case of Hungary, followed by Argentina 58.6 percent, Turkey 51.7 percent, Poland 38.7 percent and Indonesia 37.6 percent.

The rates of external debt to GNP was 17.9 percent in case of India and 12 percent in case of China. In 2009, the rate of external debt to GNP was the highest at 127.3 percent in case of Latvia, followed by Kazakhstan 95.0 percent, Romania 54.7 percent and Ukraine 51.7 percent. In case of India, rate of external debt to GDP was 19.0 percent and it was 8.7 percent in case of China. In respect of debt service rates, India had the lowest ratio of 5.5 percent, while Brazil had the highest ratio at 44.8 percent in 2009-10.

Causes of External Debt Problem:


The steep rise in external debt burden of the developing countries since 1970’s is on account of the following reasons:

(i) Aggravation of BOP deficit by oil crisis.

(ii) Persistent inflationary pressures.

(iii) Large scale lending by Western banks in the wake of conditions of recession within the developed countries.

(iv) Limited productive use of resources.

(v) Low export earnings.

(vi) Decline in the flow of concessional assistance and consequent greater reliance on costly commercial borrowing.

(vii) Deterioration in the terms of trade for primary producing countries.

Debt Relief Measures:

In view of deep debt crisis faced particularly by the LDCs, it is necessary to adopt appropriate remedial measures. The dimension of the problem can be gauged from an estimate that defaults in the foreign debt payment by just three countries. Brazil, Argentina and Mexico would render 9 major U.S. banks insolvent.


In order to tackle international debt crisis, some measures have been considered, as follows:

(i) Rescheduling of Debt:

The conservative approach propagated by advanced countries is that the debtor countries may be allowed the facility of rescheduling of debt. It involves the postponement of interest and principal payments or addition of arrears to the capital. The problem, however, is too acute to be tackled through mere rescheduling.

(ii) Growth-Oriented Structural Economic Reforms:


In the IMF-World Bank meet in 1985, the U.S. Treasury Secretary James Baker announced a plan, referred as Baker Plan. It emphasised upon the provision of new loans of the amount of $ 20 billion to the debtor countries over a period of three years, provided they are willing to undertake growth-oriented structural economic reforms in their respective countries. But Baker Plan was meant only for the debtor countries in the Western Hemisphere and had only very limited applicability.

(iii) Debt Reduction Facility:

A new facility of $ 100 million was set up by the World Bank in 1989. It was meant to provide grants to poor countries carrying out structural adjustment programmes in order to enable them to buy back or exchange their commercial debt for a relatively small percentage of its face value. This facility was deficient in two respects. First, only those debtor countries were eligible for it that had access to IDA assistance. Second, the maximum limit of grant for a debt-ridden country was just $ 10 million which was too paltry.

(iv) Debt Write-Off:


The less developed indebted countries had been demanding for long some measure of debt write-off from the creditor countries. In this regard, the Brady Plan was put forward in 1989. It dealt with mechanisms for reducing debt and debt servicing such as debt buy backs, exchange of old debt for new collateral securities at a discount and exchange of old debts for new bonds at par value with reduced interest rates coupled with policies to encourage foreign direct investment and repatriation of flight of capital from debtor countries.

The Commonwealth Finance Ministers meeting in Trinidad in 1990 proposed a plan to write off two-thirds of debt of the poorest countries amounting to $ 18 billion, to extend the repayment period to 25 years, and to capitalise the interest payments in the first five years. The Paris Club in 1991 agreed to provide for a 50 per cent reduction in the net present value of the consolidated debt-service payments on debt not associated with official development assistance.

During the 1990’s, it was observed that there was a fall in the Debt- GDP ratio and debt-service ratio in many a less developed country. But overall debt had been continuously increasing. There was also accumulation of interest arrears. In this connection South Commission had observed, “Unless these arrangements involve substantial reduction in the net transfer of capital from developing to developed countries, allowing vigorous growth to take place, they will do no more than add to the debt burden for the future.”

India and External Debt:

Right since India had launched her development programme in early 1950’s, the balance of payments difficulties coupled with large scale official external borrowing created a seriously developing situation of external indebtedness.


Features of External Debt:

The main features related to India’s external debt are as follows:

1. Total Outstanding Debt:

The total outstanding external debt of India which stood at 83.8 billion dollars in 1991 has continued to rise over the subsequent years. In 2001, the external debt had shot up to 101.33 billion dollars. It was on account of substantial increase in multilateral assistance, bilateral concessional government borrowing and export credit compared with the preceding year.

In 2002, the external debt declined to 98.84 billion dollars. This decline in external debt of India was caused by fall in bilateral concessional government borrowing, IMF credit, and export credit and rupee debt. In the subsequent years, the total external debt of India showed a sharp and sustained increase from $ 104.91 billion in 2002-03 to $ 442.26 billion in 2014-15. It happened on account of rise in trade related credit, NRI and foreign currency deposits, commercial borrowings and export credit during this period.

2. Commercial Borrowings:

Another important feature of India’s external debt has been a large increase in the commercial borrowings which raised from 12.80 billion dollars in 1989 to 23.32 billion dollars in 2001-02, an increase by 82.2 percent. The rapid increase in commercial borrowings over during this period was the pointer towards an alarming increase in debt liability of the country. Between 2001-02 and 2014-15, the commercial borrowing shot up further from 24.41 billion dollar to 147.98 billion dollar.

3. Debt Servicing Liability:

As regards India’s debt servicing liability, the projection, according to NCAER, was that India would have to pay a total of 47.2 billion dollars between 1991-92 to 1995-96 towards repayment of principal and interest.

According to an estimate by Federation of Indian Chambers of Commerce and Industry, the external debt servicing liability of India was to go up from $ 10.8 billion in 1994-95 to 12-3 billion in 1995-96 and $ 14.5 billion in 1996-97. The debt servicing ratio rose from 16.2 percent to 17.3 percent between 1999-00 and 2000-01. It declined sharply from 13.7 percent in 2001-02 to 5.9 percent in 2013-14.

4. Short Term Debt:

The high proportion of short term debt with maturity upto one year has been an indicator of instability in the economy as was evident in Mexican crisis and East Asian Crisis. In case of India, the short term external debt has declined from $ 8.5 billion to $ 5.0 billion between 1991 and 1998. By 2001-02, it had declined to $ 2.7 billion.

Between 2002-03 and 2013-14, the short term debt increased sharply from 4.67 billion dollars to 89.31 billion dollar. This development is certainly worrisome. The ratio of short term debt to total debt, which was 10.2 percent in 1991, increased to 20.2 percent in 2013-14.

5. Concessional Debt:

During the first half of 1990’s, the share of concessional debt in the total external debt of India was about 45 percent. By the end-March 2002, this ratio had fallen to 35.9 percent. But by international standards, the share of this country in concessional assistance still remained high. In 2014-15, the ratio of concessional debt to total debt had fallen to 10.5 percent.

6. Indebtedness Position:

During the 1990’s, India’s indebtedness position improved vis-a-vis other indebted countries. In term of absolute amount of debt, India had been placed at the third position after Brazil and Mexico in 1997. It was placed at the tenth position in 1999 with total external debt of $ 94 billion. India was at fifth position among the most indebted 20 countries of the world in December, 2008. In terms of the indebtedness classification, while India had been put in the category of severely indebted countries in 1991, its position had improved in 1999 and it was placed in the category of less indebted countries.

7. Prepayment of High Cost Loans:

In order to reduce the debt servicing, the country prepaid high cost loans worth $ 3 billion dollars taken from the World Bank and the Asian Development Bank during the fiscal year 2002-03. It was proposed to undertake during the fiscal year 2003-04, the prepayment of high cost loan of over $ 2.9 billion taken from the multilateral agencies like the World Bank and the Asian Development Bank.

The increasing volume of external debt, high rate of growth of non-concessional loans and high proportion of short-term debts in total external debts coupled with a high ratio of foreign debt to GNP and high ratio of external debt to exports of goods and services raised the most pertinent question; whether or not has India reached a stage of debt trap when the additional borrowings have to be obtained for making repayment of outstanding loans and interest thereon. It is no doubt, a fact that India is dangerously close to that situation.

But the conclusion related to debt trap should not be made just on the basis of the high ratio of external debt to GDP. In the case of South Korea, the ratio of foreign debt to GDP was 48.7 percent in 1980. Peaked at 52.5 percent in 1985 and then declined rapidly. In the case of Malaysia, the ratio peaked at 84.4 percent in 1986. Thereafter, it declined to 51.6 percent in 1989.

In the case of Indonesia, it was 28 percent in 1980, when the economy of that country was referred as the disaster economy. The ratio rose to 59.8 percent but its economy was still hailed as a roaring success. In case of Thailand also the ratio peaked at 45.5 percent in 1985. In all these countries the debt-GDP ratio declined in the latter half of 1980’s on account of two principal reasons—improved export performance and large flows of direct foreign investment to replace their debt-dependence.

It should not result in apathy towards high debt-GDP ratio assuming it to be a desirable thing. In 1989, Argentina had a ratio of 258 percent and it was in deep crisis. So the most crucial factor in this regard is how efficiently or otherwise a country makes use of the foreign borrowings.

The often expressed opinion that the volume of external debt should be reduced is based upon the assumption that we cannot utilise the proceeds from external debts in an efficient manner. What is really required in India is not to slash the amount of borrowings but to make a more productive use of them.

Strategy of External Debt:

To deal effectively with the problem of external borrowing, it is important to adopt better economic and financial policies over a sustained period.

The strategy should include the following main points:

(i) There should be sustained and rapid expansion of exports. If the growth rate of exports remains higher than the growth rate of external debt, the ratio of debt to exports will be brought down.

(ii) Greater emphasis should be placed on the direct foreign investments. Such capital inflows do not involve interest burden. The replacement of external debts by the direct foreign investments as a long-term strategy will certainly lead to much more favourable effects in the long-run.

(iii) The borrowed funds should be directed to such sectors or activities in which the rate of return is higher than the global interest rates. In a situation when the global interest rates are lower than the domestic interest rates and the rates of return in the sector where borrowed funds are being utilised are low, it is pragmatic to supplement the domestic savings with external borrowings.

(iv) It is of utmost importance not to blow up the borrowed funds in consumption. The return for money used in consumption is zero. In India, excessive wasteful spending by the government on consumption during 1980’s and 1990’s was one of the main reasons for increasing debt burden upon the nation. Unless the pattern of government spending is amended, the debt problem is likely to go out of control.

(v) The inefficiency exists in India not only in the public sector but also in the private sector. Even in many of those Indian industries that have borrowed funds from abroad, there are high costs and under-utilization of capacities. They are, however, sustained by internal inflation and system of controls. Their performance on the export front continues to remain disappointing. The ways and means need to be devised to improve the efficiency of the private sector industries.

(vi) In context of India, there is urgent need of effective monitoring of international financial relations. There should exist, clearly defined set of legislative regulations upon the borrowing authority in the country.

In addition, the borrowing decisions should be monitored, compiled, updated and disseminated by a central agency so that the government has at its disposal the detailed information not only about the existing debt service requirements over the next few years but also about the variations in international interest rates, export prices and exchange rates.

In order to ensure more efficient utilisation of borrowed funds, the Rangarajan Committee has made some recommendations which include the redefining or even cancelling of those projects where progress was slow so that commitment fee on “active” projects was eliminated. The Committee has also asked the Centre to pass on 100 percent of external assistance to the states in all sectors. In order to remove the funds-driven delays, the Centre should release additional assistance to states on a monthly basis.

The Committee also suggested that the plan allocation of rupee resources must attach priority to the externally aided projects. In view of the excessive loan-pushing in the late 1980’s under inducement from the major US banks, the Committee had recommended that total disbursement of export credit should be contained within the limit of 2.5 billion dollars per annum over the period of the Eighth Five-Year Plan.

(vii) India has so far not asked for the rescheduling of external debts. It has scrupulously fulfilled its external debt commitments. However in view of continuing inflation, limited prospects of raising exports at an accelerated rate, setback in trade with East European countries and the need of additional external assistance on account of structural reforms, the external indebtedness is likely to increase in the years to come.

In order to reduce the burden of international commercial debts, the Brady Plan has been initiated. Under this plan, creditor’s claims on a debtor country are reduced in three ways. First, these claims are converted into 30 years, or whatever is agreed through negotiations, discount bonds (below the face value of debts) carrying a market rate related to London Inter-Bank offer rate with full guarantee of principal to be paid in one installment after the maturity of bonds with 18 to 20 months guarantee on interest.

Second, creditor’s claims are transformed into long-term bonds at par with below market interest rate with the same maturity and guarantee structure as the discount bonds. Third, new loans are provided upto a certain proportion of the debt claims repayable on an agreed period including a grace period. More than 10 countries have so far availed of the Brady Plan.

As a result, the commercial debt claims amounting to more than 40 billion dollars have been slashed down. In July 1991, the industrial countries widened the terms under which the burden of official debt on low and middle income countries could be reduced.

The Paris Club created a mechanism through which the official debt burden could be reduced provided the debtor country could make out a case for some special circumstances warranting mitigation of indebtedness. Some countries including Egypt, Mexico and Poland have taken recourse to this arrangement and consequently there is a reduction in their debt burden by about 50 percent. India has a much better case for the debt relief than those countries that have availed of this arrangement but it is not inclined to do so presently.

If there is a sustained improvement in India’s export performance, coupled with larger inflow of direct foreign investments and reduction in cost structure in her industries, India will manage by herself the external debt situation. If these assumptions do not hold, India will have to seek rescheduling facilities and not risk slowing down her growth process and structural reforms programme.

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